Controversy over Commission proposal on the splitting of banks

In a proposal on bank structure expected at the end of January, the European Commission will shy away from advocating that large European Union banks be automatically split up to separate retail banking from riskier trading and investment activities.

The draft proposal by Michel Barnier, the European commissioner for internal market and services, thus falls far short of implementing the main recommendation of a 2012 report that he commissioned. That report, from a group of banking experts led by Erkki Liikanen, the Bank of Finland’s governor, urged that retail banks with significant trading activities be broken up.

But Barnier’s proposal does go further than the Liikanen report in one respect: it would ban the largest systemically important banks from ‘proprietary trading’, or trades made purely for the bank’s profit without any link to a client, a step broadly equivalent to the Volcker Rule introduced in the United States.

The Commission’s draft envisages that the activities of the EU’s largest 30 or so banks that are “too big to fail” but “too big to save” may be split up into separate subsidiaries by 2020. Yet it gives regulators leeway to decide whether the division should be mandatory, as well as offering exemptions for equivalent national reforms such as the Vickers reform in the United Kingdom. This is likely to include banks such as HSBC, BNP Paribas and Deutsche Bank. Mutuals, co-operatives and savings institutions, such as Crédit Agricole, the largest retail bank in France, and DeKaBank, which manages the assets of Germany’s influential savings banks, would be excused from some requirements due to the peculiarities of their legal structure.

The draft proposal “looks like a purely symbolic act”, said Sven Giegold, a Green German MEP who sits on the Parliament’s committee on economic and monetary affairs. He argued that, by leaving so much to the discretion of regulators, the system would be arbitrary and burdensome.

The question of how to regulate large banks’ ability to trade in derivatives and other complex financial products became a matter for heated debate during the financial crisis which began in 2008. There were concerns that heavy losses from derivatives relating to subprime mortgages were liable to swallow up deposits as well as having a knock-on effect on the entire financial system. In the meantime, the Commission has implemented other reforms that go a long way to protecting taxpayers and depositors from costly bank collapses.

Germany and France, both of which expressed opposition to the strict one-size-fits all rules proposed by Liikanen, stole a march on the Commission by enacting national legislation on banking structures, as did the UK and Belgium.

Ahead of the game

“The fact that a number of member states have already forged ahead in implementing banking structural reform limits the EU’s room for manoeuvre to have a harmonised approach,” said Arlene McCarthy, a centre-left British MEP who drafted a European Parliament report on reforming the structure of the banking system. The Commission should set out “a common objective” but allow member states to decide how to achieve this, she argued.

The Commission’s draft proposal, which is still being debated internally, estimates that 29 European banks based in the eurozone, the UK and Sweden would meet the thresholds for action based on data from 2006-2011, while some banks from the US and Japan would also be caught.

Where a bank triggers the thresholds, a decision on whether to enforce a split and to what extent would be taken by the relevant supervisors, namely the ECB for eurozone banks and national regulators for many non-eurozone banks. “The basic principle is that deposit-taking entities within banking groups can only engage in these activities as long as the supervisor does not decide that these activities need to be performed within a distinct trading entity,” reads the draft Commission proposal.

The draft legislation, which has been debated within the Commission since early 2013, has been the subject of intense lobbying from the banking sectors. The industry broadly argues that the changes proposed by Liikanen would impose large, unnecessary costs on its operations and lead to less funding for the European economy.